Union Pacific’s Earnings Preview: Volume Growth May Offset High Operating Costs

Union Pacific Corporation (NYSE:UNP), one of the leading railroad networks in the U.S., will report its first quarter 2014 results on April 17, 2014. We believe that volume growth and pricing gains will be a major factor driving earnings in the first quarter and countering the negative effects of high operating costs incurred due to the harsh winter weather. In the previous quarter, the company reported a 7% gain in revenue driven by strong pricing gains and modest volume growth. ^[1]

Declining coal shipments impacted overall volumes for Union Pacific throughout 2012 and 2013. However, the trend seems to have reversed in the first quarter of 2014 with growth in coal volumes. This should more than offset the decline in automotive shipments, which have been severely impacted by the harsh winter weather. Agricultural, industrial, intermodal and chemicals shipments will also grow in the first quarter, however, somewhat tempered due to the bad weather.

Union Pacific’s operating ratio (operating expenses expressed as a percentage of revenues), may be impacted by the high operating costs incurred during the quarter. We believe that pricing gains combined with volume growth may be able to offset the high operating costs and may prevent the operating ratio from deteriorating.

See our complete analysis of Union Pacific here

Revisiting Q4 2013 Results

Union Pacific posted overall volume growth of 2% in the fourth quarter 2013, despite a significant decline of 10% in coal shipments, supported by strong growth in agricultural, automotive, and industrial products shipments. ^[2] Union Pacific’s total revenue in the fourth quarter grew 7% year on year to reach $5.6 billion, driven by strong pricing gains and volume growth.

Operating expenses increased 4% compared to the fourth quarter of the previous year. However, when expressed as a percentage of revenue, the ratio declined from 67.1% to 65%. This indicates an increase in Union Pacific’s efficiency in managing its operating expenses. Union Pacific is targeting to bring the ratio down to sub-65% levels by 2017. ^[1]

Bad Weather Causes Performance Metrics To Dwindle Leading To Increase In Costs

Union Pacific’s performance metrics, such as terminal dwells and velocity, have performed badly due to the severe weather. Terminal dwell, which indicates the average time a freight car resides in a terminal, has increased 13% year over year and average car velocity has decreased 9%, both unfavorable directions of change which will impact operational costs. ^[3]

Union Pacific has had to increase crew and equipment count in order to facilitate smooth functioning of its services amidst the severe weather conditions. ^[4] This will lead to higher labor costs, rental expenses and fuel costs for the quarter which will significantly impact operating costs and operating ratio.

Coal Business May Turnaround

Union Pacific’s coal shipments declined 10% in the fourth quarter of 2013. However, coal shipments are expected to improve in the first quarter 2014 due to increased price of natural gas and easier comparison to last year’s heavily depressed volumes. Lately, natural gas prices have risen due to increasing demand and the harsh winter weather this season. This has eroded the price advantage that natural gas had over coal. In the first quarter 2014, Union Pacific’s coal shipments grew 7% year over year. ^[5] Coupled with pricing gains, we believe that the segment may post high single digit growth in revenues.

Agricultural Shipments Revenue Will Continue To Grow In The First Quarter

In the previous quarter, Union Pacific’s agricultural shipments increased by 13% resulting in a 19% increase in revenue. We expect to see growth in agricultural revenue in the first quarter 2014 primarily due to the spillover effects of the strong harvest last year which boosted agriculture shipments. Corn production grew from 273 million tons in 2012 to 355 million tons in 2013 and Soybeans production grew from 82.5 million tons in 2012 to 88.6 million tons in 2013. ^[6] This increase in production has driven Union Pacific’s grain shipments, which includes corn and soybean, by 38% in the first quarter. ^[5] Easier year on year comparisons will also have a favorable impact on agricultural shipments.

Intermodal Shipments To Post Modest Growth

Union Pacific’s intermodal revenue remained stagnant in the fourth quarter 2013 due to declines in revenue per car because of lower fuel surcharges, which offset modest growth in intermodal volumes. ^[2] Volume of intermodal shipments increased 4% in the first quarter. Revenue per car may increase due to increase in fuel surcharge driven by the rise in diesel prices over the quarter. Diesel prices increased from $3.8 per gallon in December 2013 to $4.0 per gallon in March 2014. ^[7] Volume growth coupled with increase in revenue per car may help the segment post modest growth in revenue.

Construction and Shale Related Volumes Will Help Growth In Industrials Shipments

In the fourth quarter 2013, Union Pacific’s industrials shipments grew 9% on increased shale related volumes and construction material and lumber shipments.

The shale gas boom in North America continues to drive demand for frac sand, finished pipes and other drilling commodities. Shale related volumes along with crude oil accounted for 4.5% of Union Pacific’s overall volumes in 2013, and we expect the number to increase in the first quarter and throughout 2014 with continued growth in shale related activity. ^[4]

Union Pacific’s lumber & wood products and crushed stone, gravel and sand shipments are used for commercial, residential and government construction activity. In the first quarter 2014, lumber & wood products shipments grew 2% and crushed stone, gravel and sand shipments grew 15% due to an increase in the overall construction spending in the U.S. Spending on construction increased from $928 billion in November 2013 to $945 billion in February 2014. ^[8] Growth in shipments of construction material will help drive revenues for Union Pacific’s industrial shipments segment.

Revenue From Automotive Shipments May Decline

The growing U.S. auto industry had a positive impact on Union Pacific’s automotive shipments throughout 2013. However, automotive shipments declined 4% in the first quarter 2014 due to the impact of the bad winter weather. Revenue from the segment, which accounts for 10% of the overall revenue, may suffer unless offset by pricing gains.

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1. Union Pacific Management Discusses Q4 2013 Results – Earnings Call Transcript, Jan 23 2014, www.seekingalpha.com [↩] [↩]
2. Union Pacific 2013 Fourth Quarter News Release Financials, Jan 23 2014, www.up.com [↩] [↩]
3. Union Pacific’s Weekly Performance Report, www. railroadpm.org [↩]
4. Union Pacific’s J.P. Morgan Aviation, Transportation & Industrials Conference Presentation, March 11 2014, www.up.com [↩] [↩]
5. Union Pacific’s Weekly Carloading Report, www.up.com [↩] [↩]
6. National Agricultural Statistics Service – Crop Production, www.usda.gov [↩]
7. Weekly Retail Gasoline and Diesel Prices, www.eia.gov [↩]
8. Construction Spending, www.census.gov [↩]